The City was braced tonight for a prolonged period of ultra-low interest rates after a combination of a slowing economy and cheaper food prices dragged Britain's inflation rate below the government's target for the first time in almost two years.

Analysts said the drop from 2.2% to 1.8% in the cost of living as measured by the consumer prices index (CPI) took the pressure off the Bank of England to reverse the policy stimulus that has been in place since the turn of the year.

With the broader measure of inflation, the retail price index, recording a 1.6% fall in the year to June, the newest member of the Bank's nine-strong monetary policy committee said that he was more concerned about undershooting the 2% CPI target than overshooting it.

"The risks clearly are more about deflation than inflation in the short term," Adam Posen said in testimony to the Commons Treasury committee.

Inflation has not been below the government's target since September 2007, the month of the run on Northern Rock in the early stages of the global financial crisis. It peaked at 5.2% last September in the wake of the sharp increase in oil prices and despite last month's fall remains higher than the average of 0.7% for the 27 nations in the European Union and -0.1% for the 16-country eurozone.

Howard Archer, chief UK economist at IHS Global Insight, said: "The June inflation data broadly reinforce our belief that the Bank of England can afford to keep interest rates down at 0.5% well into 2010. The data also do little to dilute our belief that the Bank of England could very well increase its quantitative easing programme in August despite its inaction at its July MPC meeting, particularly if economic and bank lending data disappoint over the coming month."

The main factor behind the lower inflation rate was food and non-alcoholic drinks, which fell to 5.4% last month, from 7.8% in May. The furniture sector also pulled down CPI, with the trend of retailers increasing prices before the summer sales becoming less apparent since the collapse of MFI.

Retail price inflation, which strips out housing costs, fell from -1.1% in May to -1.6% in June, its lowest level since 1948.

Brendan Barber, the TUC general secretary, said: "The severe drop in both main measures of inflation shows how close the UK economy is to a deflationary phase. This would have a very serious impact on jobs, growth and investment.

"There is a strong political consensus behind the Bank of England's bold measures to limit this risk, but it is illogical to argue simultaneously for massive cuts in public spending."

Posen said that the British economy should return to growth by 2010, but the road to recovery will be bumpy. "I would be surprised not to have positive growth by 2010, possibly earlier, but it's not going to be a smooth ride," the US economist said at his appointment hearing. Posen, who is deputy director of the Peterson Institute, a Washington thinktank, will replace Tim Besley in September, when he moves to Britain to take up his new role.